News of a credit rating downgrade, such as that handed to Western Australia’s government by Moody’s this week, is a state treasurer’s worst nightmare.
But it need not be disastrous if it serves to jolt the government into a more prudent fiscal policy.
On this occasion, the shock value may be diminished by the fact that Standard & Poor’s had already knocked WA off its AAA perch last year. But the lesson to the Barnett government is that it needs to do much more to reverse the slide in the state’s fiscal position.
State treasurers cherish AAA ratings for a number of reasons. One is the lower cost of borrowing made possible by the highest rating, but experience has shown that the difference in interest cost between an AAA and an AA credit is not substantial.
More important to state treasurers is the threat of a downgrade as an instrument of discipline on spending decisions. Their fear is that the loss of the top rating will be the beginning of a slippery slope as their colleagues get a taste of loose fiscal settings and agitate to test the limits.
They also know that an AAA rating is much easier to lose than it is to get back.
On the positive side, the rating has symbolic value as an external seal of approval or disapproval of a government’s economic management, and a signal to the private sector of the stability or otherwise of the climate for investment.
A AAA rating is also a handy defence in times of global financial chaos, even if it doesn’t make much difference in normal financial conditions.
WA’s loss is the latest milestone in the unravelling of Australia’s very strong pre-2008 public finances.
Beginning with Queensland in 2009, three states lost AAA ratings before WA, and both NSW and Victoria were pushed to the brink, not to mention all that has happened at the Commonwealth level without yet threatening its credit rating.
One of the common themes in these events is that the growth of government spending in the years of buoyant revenue turned out to be unsustainable when revenue returned to normal and governments were slow to recognise the new realities.
This was clearly the case in WA, where general government operating expenses grew at a decade average of 8.7 per cent a year up to 2013-14. This was a very high rate of growth, even allowing for population growth of around 3 per cent a year. The 2014-15 budget points to a drop in expenses growth to only 3.5 per cent in the next four years, but the rating agencies are right to be sceptical about this as well as about projections of mining revenue.
At the same time as operating expenses have been galloping ahead, capital (infrastructure) expenditure has also been ramped up, from less than $1.5 billion a year before 2007-08 to more than double that in recent years.
No doubt, some of that increase has been worthwhile, but there are major doubts about the value of some projects.
WA governments from both sides have complained bitterly about the state’s shrinking share of GST revenue, as the horizontal equalisation process redistributed revenue to other states in recognition of very strong growth in WA’s royalties from mining. WA may well have grounds for complaint about the way horizontal equalisation works, but the fact remains that the state’s total budget revenue expanded by 8 per cent a year on average in the 10 years to 2013-14.
The problem wasn’t a shortage of revenue, but an excess of expenditure, which grew even faster, thereby breaching one of the government’s own key financial targets. The net result is that operating surpluses have virtually disappeared and the cash result has gone deep into deficit, driving net debt from a negative level as recently as 2009-10 to a substantial positive magnitude.
These figures refer to the budget sector, but rating agencies also look at the public corporations sector, where measures of indebtedness have deteriorated even more markedly. Non-financial public sector net debt (which includes non-financial corporations as well as the budget sector) exceeds the government’s self-imposed ceiling of 55 per cent of revenue.
All told, it is difficult to disagree with the credit rating agencies about WA.
Now, Treasurer Mike Nahan, having seen his worst nightmare come true, faces the long, hard slog of stopping the rot and then trying to retrieve the AAA rating in time for the next global financial crisis.
Robert Carling is a Senior Fellow at The Centre for Independent Studies.
Home > Commentary > Opinion > Where to find the silver lining when a AAA rating vanishes
Where to find the silver lining when a AAA rating vanishes
News of a credit rating downgrade, such as that handed to Western Australia’s government by Moody’s this week, is a state treasurer’s worst nightmare.
But it need not be disastrous if it serves to jolt the government into a more prudent fiscal policy.
On this occasion, the shock value may be diminished by the fact that Standard & Poor’s had already knocked WA off its AAA perch last year. But the lesson to the Barnett government is that it needs to do much more to reverse the slide in the state’s fiscal position.
State treasurers cherish AAA ratings for a number of reasons. One is the lower cost of borrowing made possible by the highest rating, but experience has shown that the difference in interest cost between an AAA and an AA credit is not substantial.
More important to state treasurers is the threat of a downgrade as an instrument of discipline on spending decisions. Their fear is that the loss of the top rating will be the beginning of a slippery slope as their colleagues get a taste of loose fiscal settings and agitate to test the limits.
They also know that an AAA rating is much easier to lose than it is to get back.
On the positive side, the rating has symbolic value as an external seal of approval or disapproval of a government’s economic management, and a signal to the private sector of the stability or otherwise of the climate for investment.
A AAA rating is also a handy defence in times of global financial chaos, even if it doesn’t make much difference in normal financial conditions.
WA’s loss is the latest milestone in the unravelling of Australia’s very strong pre-2008 public finances.
Beginning with Queensland in 2009, three states lost AAA ratings before WA, and both NSW and Victoria were pushed to the brink, not to mention all that has happened at the Commonwealth level without yet threatening its credit rating.
One of the common themes in these events is that the growth of government spending in the years of buoyant revenue turned out to be unsustainable when revenue returned to normal and governments were slow to recognise the new realities.
This was clearly the case in WA, where general government operating expenses grew at a decade average of 8.7 per cent a year up to 2013-14. This was a very high rate of growth, even allowing for population growth of around 3 per cent a year. The 2014-15 budget points to a drop in expenses growth to only 3.5 per cent in the next four years, but the rating agencies are right to be sceptical about this as well as about projections of mining revenue.
At the same time as operating expenses have been galloping ahead, capital (infrastructure) expenditure has also been ramped up, from less than $1.5 billion a year before 2007-08 to more than double that in recent years.
No doubt, some of that increase has been worthwhile, but there are major doubts about the value of some projects.
WA governments from both sides have complained bitterly about the state’s shrinking share of GST revenue, as the horizontal equalisation process redistributed revenue to other states in recognition of very strong growth in WA’s royalties from mining. WA may well have grounds for complaint about the way horizontal equalisation works, but the fact remains that the state’s total budget revenue expanded by 8 per cent a year on average in the 10 years to 2013-14.
The problem wasn’t a shortage of revenue, but an excess of expenditure, which grew even faster, thereby breaching one of the government’s own key financial targets. The net result is that operating surpluses have virtually disappeared and the cash result has gone deep into deficit, driving net debt from a negative level as recently as 2009-10 to a substantial positive magnitude.
These figures refer to the budget sector, but rating agencies also look at the public corporations sector, where measures of indebtedness have deteriorated even more markedly. Non-financial public sector net debt (which includes non-financial corporations as well as the budget sector) exceeds the government’s self-imposed ceiling of 55 per cent of revenue.
All told, it is difficult to disagree with the credit rating agencies about WA.
Now, Treasurer Mike Nahan, having seen his worst nightmare come true, faces the long, hard slog of stopping the rot and then trying to retrieve the AAA rating in time for the next global financial crisis.
Robert Carling is a Senior Fellow at The Centre for Independent Studies.
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